Do not believe government pronouncements
that the economy is rebounding from very minimal damage caused by unprecedented
Covid-19 inspired closures of businesses. Government will use its favorite
statistic of the health of the economy to justify its actions--Gross Domestic
Product (GDP).
GDP is supposed to represent the total
of spending in the economy. It is a Keynesian term that elevates a concept
called "aggregate demand" as most important. Not production and
especially not savings. In fact Keynesians fear savings most of all. Now, you
and I know that we can become wealthier only by saving some of our income and
investing it wisely for the future. But Keynesians invented a concept called
"The Paradox of Thrift", whereby they claim that the economy enters a
death spiral from reductions in spending caused by an increase in savings. Individually
savers may be better off, they say, but collectively the economy suffers. For
example, the new auto that we savers do not buy, but rather keep our old one in
good repair for a few more years, denies the automakers and all who work for
them the money they need to continue production. Layoffs and plant closings
ensue. The reduction in aggregate demand ripples outward, bankrupting more and
more support businesses and their employees. This is the simplistic Keynesian
view of savings.
But what happens to the money that we
do not spend on as many new cars? Is it
thrown down a rat hole? No, of course not. It is invested in longer term
production processes that will yield even more wealth than if we had continued
our former practice of buying new cars more often. Austrians call this
phenomenon a change in the "structure of production". We may produce
few automobiles now, but later we'll have access to products and services that
would not have existed without our previous investment. We see this in our personal
financial profiles. Our savings accounts increase at a compounding rate,
allowing us to live a more comfortable existence later in life. This is the
truth that used to be drilled into all of us before governments' in-house
economists propagandized that by being frugal we were denying our fellow
citizens what was rightfully theirs: i.e. our money and our future. It's
nonsense.
But, you may ask, where does GDP enter
the picture? Remember, aggregate demand is measured by spending, which becomes
GDP. There are two critical problems with GDP. One, it does not capture spending on longer term and
intermediate term production, but rather mostly retail sales. Headlines that
retail sales are up are supposed to generate confidence that all is well with
the economy. But is it? If you and I spend all our savings and even borrow
more, we would soon find ourselves in the poor house. But Keynesians would say
that our individual financial difficulties were good for the economy. Anybody
buying that? I certainly hope not!
GDP Captures Price Inflation and Calls It Economic
Growth
But the biggest problem with GDP is the most
obvious one--that GDP measures price increases, not increases in the production
of real goods or services. For example, in the past month or so the price of a
gallon of regular gasoline in my home state of Pennsylvania has gone up from
just under $2.50 to around $3.00. That's a twenty percent increase in price.
Since gasoline consumption changes little in the short run, selling the same
volume of gasoline at a higher price causes GDP to go up. But our standard of
living just went down! Our increased dollar spending on the same amount of
gasoline had to come from somewhere. We had to cut back somewhere else, either
some other consumption item or, most likely, a reduction in savings. Whereas
government says that the increase in GDP means that we are better off, actually
we are worse off.
Increases in the Monetary Base and M2 Are Harbingers
of Future Price Inflation
The best measure of long term price
inflation is not necessarily measuring retail prices in the short run but
measuring the increase in the money supply over time. If the money supply
increases, eventually this increase will work its way into the price structure.
It can do nothing else. The two statistics that best measure the money supply
are the "Monetary Base" and "M2". The monetary base consists
of all cash, wherever held, plus bank reserves held at the Federal Reserve Bank
which may be converted into cash on demand by the banks. It is called the
monetary base because banks can create money out of thin air by pyramiding
loans on top of their reserves at roughly a ten to one ratio. Just after the
2007/8 Subprime Lending debacle the monetary base was $.910 trillion. The Fed
juiced the monetary base to bail out the banks, so that in January 2020, just
prior to the Covid-19 lockdowns, it stood at $3.443 trillion. That's a 278%
increase. After the Covid-19 lockdowns the Fed juiced the monetary base again.
Today it stands at $5.248 trillion, a further increase of 52% over the already
inflated January 2020 level. And we haven't seen the effect of the recently
passed $1.9 trillion stimulus bill! Since this government helicopter money will
be funded completely by money printing by the Fed--a process called
"monetizing the debt"--the full amount will go directly into the
monetary base as the checks are either cashed or deposited to the recipients'
bank accounts.
M2 is the broadest measure of the money
supply that can be accessed by the public on demand. It comprises cash in the
hands of the public (but not cash in bank vaults plus money in checking and savings
accounts. M2 has exhibited similar meteoric increases. M2 stood at $7.215
trillion in 2008, then was juiced to $15.419 trillion by January of last year.
It now stands at $19.384 trillion. That's
a 169% increase, and tracks very well with independent measures of price
inflation of ten percent compounded per year (ShadowStats and the Chapwood
Index). The $1.9 trillion third stimulus program will add dollar for dollar to
M2 initially. If the banks pyramid more lending on top of this increase in
their reserves, M2 will continue to grow beyond the $1.9 trillion. This is
exactly what the government wants, because it will goose GDP.
The lesson is this--don't be fooled by
government statistics, especially GDP, that the economy is recovering nicely
from the Covid-19 lockdowns. The Covid-19 lockdowns have caused immense damage
to the economy. Government money printing may goose GDP, but It will do nothing
to compensate for the dead weight loss
that millions have suffered.
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